An update on the Microchip Thesis


[DATED MARCH 2017 via Jarvus Friends and Family Fund prior to Third Wave Capital inception]

One year ago in March 2016 I wrote to friends and colleagues that there was a severe undervaluation of microchip stocks across the board. It seemed at the time that the slow down in PC sales growth caused over selling in microchip sectors considered to be completely reliant on PC sales. However, what was ignored was the increased demand in chips from non PC segments including data centers, mobile, auto, and wearables. The growing trend for mobility drove down PC sales as the consumer demanded ever smaller, more mobile,  more flexible devices to consume digital content. That same trend, however, ignited multiple sector demand for microchips that is proving to far exceed the growth rate potential that the PC sector alone holds. Not only did the consumer demand smaller devices requiring more chips, but the device services evolved to meet the mobility requirement by pushing further into the cloud. The increased reliance on the cloud has created a massive growth rate increase in data centers and the products and services they need to operate. Thus, at the very same time that microchip & semiconductor stocks were being over sold, the demand for those businesses’ products began accelerating. This presented opportunity to buy stocks facing parabolic industry growth for pennies on the dollar, a value investor dream.

At the time of my initial letter I suggested the following stocks were undervalued and would see tremendous upside from the industry trajectory:


Stock 3/10/2016 (open) 4/7/17 (closing) Gain/Loss
NVDA 31.91 100.33 214.42%
AMD 2.29 13.52 490.39%
WDC 47.88 85.17 77.88%
STX 34.33 46.85 36.47%
AVGO 143.46 218.25 52.13%
AMAT 19.34 38.93 101.29%
TXN 55.45 80.53 45.23%
QCOM 51.91 56.32 8.50%
SWIR 13.81 26.1 88.99%
AAOI 17.05 44.68 162.05%
MXIM 33.96 45.02 32.57%
MCHP 47.56 74.06 55.72%
SWKS 71.5 101.82 42.41%
CY 8.39 13.59 61.98%
ON 8.96 15.15 69.08%
XLNX 46.58 56.48 21.25%
MU 10.95 28.52 160.46%
ADI 55.46 80.01 44.27%


With the exception of Qualcom, you can see that the thesis proved fruitful (QCOM paid a nice dividend along the way though). We took long 2018 out of the money call options on NVDA AMD AMAT CSCO AAOI & WDC which helped us to return more than 600% gains on our deployed capital.

A year later it’s time to take a look back the original thesis to determine how we intend to update our strategy. After seeing such lucrative returns it’s hard to justify continued purchasing, but that is exactly what we’re doing. We believe that the street continues to underestimate the industry growth driving increased demand for chip makers and data center suppliers. Despite the tremendous gains over the past year, we believe that a few of these stocks will continue their upward trajectory as more accurate industry metrics begin to price in.

It is our belief that even the most rigorously investigated guidance is underestimating the worldwide trends driving the increase in sales for chips and data center suppliers. The following picks on our list are picks that we consider growth stocks that still maintain a PE of less than 30: NVDA, STX, MXIM, AAOI, XLNX, TXN, SWKS, AMAT, QCOM, and the following maintain a forward PE of less than 25: WDC, AVGO, CY, SWKS, MU, ON. We believe that industry demand will outpace the projected earnings growth and prove these stocks to be undervalued even at current prices.

We will be actively trading long call options on most of the stocks listed above, while we focus our long term equity purchasing on the dividend growth stocks like WDC, STX, TXN, QCOM, AVGO, & NVDA. We think that despite the lack of clarity in metric valuation, AMD will likely see a climb above $20 as well. AMD is in a strong and growing market position, with leadership focused on restructuring the company finances, so there is enough potential for upside surprises that we’ll be engaging in bull call spread option strategies on AMD for the foreseeable future.

While we believe that macro economic variables point towards a strongly recovering economy that will see asset buying power continue to rise and potential unforeseen inflation, we will begin hedging our downside risk to lock in our gains. Any time a market makes an upward move as strongly as the one that our markets have over the past 6 months, there is destined to be profit taking and cautious buying. We think the potential for a 5-8% correction over the next 3 months is high, however we see a non-recession recovery happening swiftly and returning us to the bull track we’re on now. As such, we will be purchasing OTM puts on various ETFS that most closely represent our holdings.


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John Fazio

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By John Fazio